Macroeconomic Variables and the Sovereign Risk Premia in EMU, Non-EMU EU, and Developed Countries
Empirica, 02/2015; DOI 10.1007/s10663-015-9286-2
40 Pages Posted: 16 Nov 2015
Date Written: October 14, 2014
This project studies and models key macroeconomic variables and their impact on sovereign risk premia across some European economies and developed countries. The sample is divided into groups of countries in the European Monetary Union (EMU), the 'standalone' economies that are outside the EMU but are members of the broader European Union (EU), and other developed economies. The main subject of examination across all the groups is the impact of macroeconomic variables on sovereign borrowing costs. Our analysis relies on the five-year credit default swaps (CDS) spread as a leading forward indicator in sovereign finance. The paper also presents a graphical presentation of the time series of sovereign and corporate CDSs and monetary policy actions. A nonlinear model predictive control (NMPC) method is used to solve for different variants of the dynamic macro model. In the empirical section, GARCH modeling is applied to show interrelations of the volatilities of the five-year sovereign CDS for each group. We find that the volatility of the country risk premia is similar in both the high- and low-financial stress regime countries, therefore volatility does not detrimentally differentiate the sovereign CDS. A nonlinear vector smooth transition autoregressive (VSTAR) model is applied to investigate instabilities in the financial sector (based on sovereign CDS) and Industrial Production Index. The paper finds that regime-switching takes place rather suddenly in most EMU countries. EU countries that are not members of the EMU also experienced high financial stress and a rapid rise in the CDS spread as a result of the formation of the EMU. Due to the potential spillover effect in the European Union, the individual country macroeconomic indicators were undermined.
Keywords: debt crisis, Vector STAR, GARCH, regime-switching, euro area, financial stress
JEL Classification: E44, F34, G15
Suggested Citation: Suggested Citation